2008/2009 > TOPGLOBAL ECONOMIC CHALLENGES10 FACING AMERICA’S 44t h PRESIDENT

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Global Economics Emerging Markets Global Poverty

Erik Berglöf Mauricio Cárdenas Jessica Cohen Paul Blustein Navtej Dhillon Raj Desai Barry Bosworth Clifford Gaddy William Easterly Chad Bown Xiao Geng Maria-Luisa Escobar Colin Bradford Barry Ickes David de Ferranti Lael Brainard Santiago Levy Amanda Glassman Ralph Bryant Leonardo Martinez-Diaz Carol Graham > Peter Blair Henry Arvind Panagariya Charles Griffin Domenico Lombardi Djavad Salehi-Isfahani Richard Joseph Warwick McKibbin Ernesto Talvi Homi Kharas Adele Morris Shang-Jin Wei Michael Kremer Eswar Prasad Wing Thye Woo Johannes Linn Lex Rieffel Tarik Yousef Caroline Moser Kenneth Rogoff Wei Zhang Jane Nelson Neil Ruiz Ngozi Okonjo-Iweala Peter Wilcoxen John Page Noam Unger Jacques van der Gaag

B BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT The Top 10 Global Economic Challenges Facing America’s 44t h President By Lael Brainard

ith America’s next president taking office at a moment Wof consequential global challenges that even the THE 2008/2009 TOP 10 GLOBAL most powerful nations cannot resolve on their own, there is ECONOMIC CHALLENGES a clear need for leadership. But with U.S. financial turmoil Edited by Lael Brainard reverberating against the backdrop of a profound global shift > in economic power, America’s capacity and will to provide that 1. Restoring Financial Stability leadership are less clear. Nonetheless, given America’s enormous By Eswar Prasad stakes in a strong and resilient global economy, it will be critical for America to lead on the main challenges we face today. 2. Setting the Right Green Agenda By Warwick McKibbin, Adele Morris and Peter Wilcoxen The Global Context 3. Exercising Smart Power The “made in the USA” financial crisis comes at the same time By Lael Brainard and Noam Unger economic policymakers are confronting the emergence of a 4. Reimagining Global Trade group of rising powers, from and to the Gulf states By Paul Blustein and . We are now living in a rapidly shifting economic environment. Following 35 years of strong economic output by 5. Navigating China’s Rise the Group of Seven economies, during which they commanded By Wing Thye Woo approximately 65 percent of the global output and the so-called 6. DECIPHERING “Russia, Inc.” “BRIC“—, Russia, India, China—economies accounted By Clifford Gaddy for about 7 percent, we have seen the Group of Seven’s share 7. Engaging an Emerging India falling to 58 percent over the past five years and the BRIC’s By Eswar Prasad share rising to more than 11 percent. By 2030, according to Brookings expert Homi Kharas, the two groups are expected 8. Revitalizing Ties to Latin America to converge towards parity, with each accounting for about By Mauricio Cárdenas and Leonardo Martinez-Diaz one-third of world output. The BRICs and other emerging 9. Supporting Africa’s Growth economies are booming, integrating into the global economy, Turnaround and learning to assert their interests more forcefully. By John Page 10. Pursuing a Positive Agenda This revolution in national income shares is emblematic of a for the broader global dispersion of wealth and economic dynamism. By Navtej Dhillon, Djavad Salehi-Isfahani and In contrast to the shift of the world’s financial epicenter from Tarik Yousef the City of London to Wall Street in the interwar period, stock

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 1 INTRODUCTION: The Top 10 Global Economic Challenges Facing America’s 44t h President

markets and commodity exchanges are now proliferating in grassroots efforts to raise spending on HIV/AIDS and multiple financial centers; thus, in 2006, 18 of the 20 largest provide debt relief, U.S. military and foreign policy circles initial public offerings took place outside the U.S. and were have come to recognize the fight against global poverty as spread out among 11 stock exchanges. Indian and Brazilian a fight of necessity—not only because personal morality multinationals have made major acquisitions of flagship demands it but also because U.S. national security does as European and North American brands. And in 2007, a new well. These two converging strands have helped provide breed of sovereign wealth funds injected more capital into the biggest boost to U.S. foreign assistance in decades, shaky U.S. and European financial institutions than the along with a proliferation of uncoordinated institutional International Monetary Fund provided to Asian economies arrangements to administer it. at the height of their financial instability in 1997. In the next few years, every one of these challenges will be further complicated by the belated and patchwork The Challenge attempts to mitigate and adapt to a changing global The rapid growth of the rising powers is creating enormous climate. A fundamental transformation of the world’s opportunities but also putting considerable strain on economic paradigm away from the carbon foundations of resources from food to water to energy, contributing to the past nearly two centuries will require vast global flows global inflationary pressures, just as humanity is waking of technology and capital. up to the urgent need to wean the world’s economy from its centuries-long dependence on carbon. Growing global integration also creates growing interdependence and mutual America’s Opportunity vulnerability—most visibly to financial turmoil—but also The top 10 global economic challenges awaiting the next to food and energy shortages, pandemics, and vortexes of President defy easy solutions but are vital to the prosperity conflict and poverty. and stability of America and the world:

The size, complexity, and opacity of financial transactions in 1. Restoring financial stability: With our financial the context of an outdated regulatory structure have shredded troubles at the center of the current global vortex, the the traditional U.S. financial policy playbook. The recent U.S. has important obligations to strengthen the global actions by the U.S. Treasury and the Federal Reserve to financial system, including by strengthening our own intervene in the U.S. financial system through unconventional financial regulation and diminishing our reliance on means on an unprecedented scale have added to foreign foreign credit. The next U.S. president should work skepticism over Washington’s conventional liberalization with the international community to develop a common agenda. It will be many years before U.S. policymakers will agenda for managing capital flows, including increasing be able to make the case for the full liberalization of capital flexibility in exchange rates to facilitate the adjustment flows in emerging markets. To many audiences in emerging of persistent imbalances, developing global codes for markets, China’s heterodox growth model, in particular, has improved transparency of new players such as sovereign gained considerably greater allure. wealth funds, and updating the mission and governance of the international financial institutions to address Growing integration on the real side of the global economy today’s challenges and engage today’s players. is similarly complex. Though trade ministers sign all types of bilateral and mini-lateral trade agreements, and global trade 2. Setting the right green agenda: It is past time to muster flows are going gangbusters, multilateral and major regional the political will to act on climate change at the national trade negotiations are going bust. level while also working to forge international agreement so that markets and regulatory policy will provide a Although polarization has grown on trade, there is consistent set of incentives to wean the economy from growing convergence on the critical importance of global carbon foundations. It will require a delicate balance of development. While the U.S. public has rallied around persuasion and pressure to induce the fastest growing

2 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT emitters of greenhouse gases to take action in the face of 7. Engaging an emerging India: America has enormous concerns about growth. It will require much assistance and interests in India’s successful integration into the global financing to help the most vulnerable nations adapt. And economy as the world’s most populous engages it will inevitably risk trade frictions as competitiveness in the task of lifting hundreds of millions out of poverty. concerns come to the fore if America takes on obligations Yet India poses challenges in areas ranging from integrating ahead of its trade partners. global agricultural markets to combating climate change, and the country’s success in global high value services 3. Exercising smart power: Investing in the , markets has complicated America’s internal debate on health, livelihoods, and the security of the world’s poorest trade. America must look for areas of cooperation where not only makes Americans feel good about themselves possible and deepen bilateral engagement broadly in order but also makes the world feel good about America. It to make progress on its agenda. is critical to capitalize on the upsurge of support for global development among the U.S. public evidenced 8. Revitalizing ties to Latin America: The in increased advocacy, service, and individual giving to has deep and abiding interests in vibrant economic make sustained investments in lifting up the lives of the relations with the nations of the Western hemisphere and poor. It is critical to increase not only resources but also a growing population with roots in the region—which are the impact of each dollar spent. not matched by the quality of its engagement. America must become a stronger partner to its neighbors and 4. Reimagining global trade: Americans feel most secure engage on issues of mutual concern, including on energy, about global engagement when they are well equipped environmental protection, economic competitiveness to compete and have insurance against economic risks. and social policies. This requires vigorously enforcing the trade rules and investing in economic competitiveness—lifelong 9. Supporting Africa’s growth turnaround: Many African learning, innovation, infrastructure—to widen the circle nations have experienced dramatic, sustained growth of winners, while at the same time developing effective during the past decade due in part to improved policy and portable insurance systems for unemployment, frameworks and increasing global demand for their health, pension, and earnings to provide economic products. America can become a stronger and steadier security in the face of job dislocation. partner to Africa as it navigates economic challenges by supporting global standards for natural resource 5. Navigating China’s rise: America will need to engage management, opening markets to African products, intensively bilaterally, regionally and multilaterally supporting vibrant private enterprises, supporting African to shape China’s continued integration with the efforts to enhance regional security and build resilience international system of rules. On issues such as climate to climate change, and both increasing and improving change, enforcement of trade rules and exchange rate the quality of development assistance. adjustment, where the stakes are simply too high to ignore, America should look for cooperative mechanisms 10. Pursuing a positive agenda for the Middle East: Though to advance its goals where possible but continue to press America’s leaders view the Middle East through the bilaterally and better deploy regional and international prism of Islamic radicalism, many of the region’s leaders mechanisms where necessary. see their own core challenge as providing educational and economic opportunities for their burgeoning youth 6. Deciphering “Russia, Inc.”: Difficult as it may be to populations. America can build partnerships in the region accomplish, America nonetheless has significant interests based on trust and mutual respect if it aligns its agenda in alternately coaxing and goading a resurgent, resource on economic and political reform with the aspirations of nationalist Russia toward international norms and the majority of the region’s people: the young who are cooperation on energy, trade, financial integration and striving for opportunity and global integration. security more broadly.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 3 1 Restoring Financial Stability

By Eswar Prasad

uring the fall of 2008, the U.S. financial system any. But these obvious signs of malfeasance were all too easily ignored when times were good and the policy culture was careened on the edge of a meltdown, with the D hostile toward regulation. U.S. government effectively becoming the guarantor, Clearly, financial innovation without effective regulation lender and even investor of last resort. Whatever the does not work well. In the new world of more sophisticated final outcome of the ongoing turmoil on Wall Street, one financial markets, dangers lurk in hidden places. Central bankers and policymakers from Brazil to China have so far thing is certain: The rest of the world will no longer be as been spared the worst. Having resisted these lightly regulated enthusiastic about adopting the free market principles financial innovations to some degree, they can now be grateful that their economies have not yet been pummeled by the that have guided U.S. financial development. And current unfolding crisis as much as America’s has been. massive U.S. government interventions will also make it In this decade, the emerging markets have become major difficult to convince other nations that the state should players in international finance, not only receiving large stay out of the workings of the financial system. inflows of private capital but also exporting large amounts of capital. Indeed, since 2000, industrial countries as a group have been running a current account deficit, which has been The Global Context financed by the emerging market countries and, according For years, credit in the U.S. has been easy and regulation has to the International Monetary Fund, has reached more been light, with a resulting explosion of questionable lending than $450 billion annually. Meanwhile, the proliferation practices and novel, poorly understood financial instruments. of new financial instruments and the rising prominence The famous “ninja”—no income, no job and no assets— of new players—sovereign wealth funds, hedge funds and mortgage loans were as clear a sign of regulatory negligence as institutional investors such as pension funds—have also

4 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT changed the landscape, raising a number of challenges as the >> Currency issues: A number of emerging market economies, world becomes more financially integrated. while ostensibly moving toward more flexible exchange rates, seem to have a “fear of floating.” This is evident One thing the U.S. financial crisis proves is that fraud, in intensive management of the nominal exchange rate corruption and government interference can eat away at the through intervention in the foreign exchange market. foundations of even the deepest financial systems, especially This results in the rapid accumulation of foreign exchange when these problems are compounded by a regulatory system reserves when countries are trying to manage currency that is too narrow and rule-bound in its outlook and that, appreciation. Not only do these countries deprive themselves at times, turns a blind eye to obvious rot in the system. As of a shock absorber; they also create ground for instabilities they embark on their own financial sector reform agendas, in international capital markets. emerging markets such as China and India will learn much from the lessons of the painful U.S. experience. >> Common platforms: It goes without saying that the traditional international financial institutions, such as the International Monetary Fund and the World Bank, still The Challenge have a potentially important role to play in the smooth In this context, the next U.S. president faces a challenge with functioning of the international financial system. However, several dimensions: these institutions have been enervated by their small capital base relative to the volume of international capital flows. >> Lessons from the financial crisis: The U.S. financial Moreover, the relatively modest share of total voting rights crisis confirms that some types of government involvement that emerging markets and developing countries have in in financial markets—especially through the implicit these institutions has further undermined their effectiveness backing of ostensibly “private” institutions—generates because these countries do not see these institutions as bad outcomes that inevitably end up with taxpayers being advocates for their own interests. footing the bill. The real lessons from the Fannie Mae and Freddie Mac debacle should be about the dangers of implicit government guarantees coupled with moral America’s Opportunity hazard and weak regulation, and the risks that lurk even The next U.S. president should work with the international in advanced financial systems. community to develop a common agenda for managing capital flows. Though each group of countries, depending >> New players: The proliferation of hedge funds and mutual on their level of development and openness to international funds, and the amounts of money now controlled by them, financial flows, will have a different perspective on the agenda, have created concerns about the higher volatility of capital joint action can be based on themes of common interest. As flows. Indeed, the increasing integration of international the largest economy in the world and one of the key players financial markets has, if anything, increased the risk of in international financial markets, the U.S. also has its own herding behavior, where capital flows are driven more by obligations to keep the system working well. The current sentiment than by fundamentals. At the same time, it is U.S. financial crisis indicates that a set of rigid rules allows equally plausible that institutional investors such as pension resourceful financial institutions to mask riskiness in their funds have a longer-term investment horizon and can add portfolios or shift things around to make standard risk metrics stability to the markets. appear better than they really are. Instead of a regulatory framework that accounts for every specific financial instrument >> Political agendas: Certain new players—such as sovereign and institution, it would be preferable to develop a “principles- wealth funds, which collectively control more than $3 based” framework that can adapt to the evolution of financial trillion, by some estimates—are raising concerns about markets and can adopt a broader approach to managing countries using these institutions to further their own systemic risks. This framework should address several issues: political agendas. This has also generated worries in countries such as the U.S. that allowing domestic assets >> The U.S. fiscal problem: One of the factors behind the (firms, real estate) to be taken over by SWFs could create large U.S. current account deficit and the vulnerability of a threat to national security and broader national interests. the dollar to a sharp fall in value is the high level of the U.S. Thus, the increasing size of SWFs and their attempts budget deficit. The U.S. current account deficit also creates to make investments in some of the “crown jewels” of the risk of a disorderly adjustment in world exchange rates; countries such as the U.S. makes investment protectionism this turmoil could be especially harmful to emerging markets. a politically combustible issue, especially in view of their Getting its own house in order will be important for the U.S. lack of transparency. to be able to exercise an effective leadership role.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 5 >> Managing capital flows: The U.S. administration should Want to Read More? encourage initiatives, for instance those undertaken by the Kose, M. Ayhan, Eswar Prasad, Kenneth S. Rogoff, and International Monetary Fund, to create a set of standard Shang-Jin Wei. Financial Globalization: A Reappraisal. operating procedures for SWFs. This would allow them National Bureau of Economic Research Working Paper to be better monitored, in exchange for fewer restrictions 12484, 2006. on the investment opportunities made available to them. Mechanisms for managing official capital flows in a more Lombardi, Domenico. “Governance: The Key to Effective transparent way would be useful. For its own part, the Policies Is Accountability,” Finance & Development, U.S. needs to think about more efficient ways of delivering vol. 45, no. 3 (September 2008), www.brookings.edu/ foreign that boost growth, minimize resource loss in opinions/2008/09_global_governance_lombardi.aspx. the process of making aid transfers and do not create aid dependence in recipient countries. Martinez-Diaz, Leonardo. “Executive Boards in International Organizations: Lessons for Strengthening IMF Governance,” >> Currency issues: Countries like China should be 2008, www.brookings.edu/papers/2008/05_global_ encouraged to allow greater flexibility in their exchange governance_martinez_diaz.aspx. rates. There is a case to be made that prolonged intervention in currency markets creates instabilities in international Prasad, Eswar. “Exchange Rate Flexibility in China: Why financial markets, which could ultimately hurt the very it Really Matters and How to Make Progress,” Testimony countries that are trying to forestall currency fluctuations. before the Senate Finance Committee, March 28, 2007. Moreover, many Asian countries as well as Gulf states that have tied their currencies to the dollar are facing Prasad, Eswar, and Raghuram Rajan. “A Pragmatic Approach complications in domestic macroeconomic management, to Capital Account Liberalization,” Journal of Economic particularly the control of domestic inflation. More Perspectives, Summer 2008. important, exchange rate flexibility can play a key role in advancing countries’ own reform priorities, including Prasad, Eswar, Raghuram Rajan, and Arvind Subramanian. financial sector reforms and monetary policy frameworks “Foreign Capital and Economic Growth.” Brookings Papers that can respond more nimbly to domestic needs. on Economic Activity, 2007. >> Global governance: The U.S. should support further Rieffel, Lex. “The International Monetary Fund and the changes to the governance structure of international World Bank: It’s Time to Separate the Conjoined Twins.” financial institutions such as the International Monetary Brookings Global Working Paper 22, September 2008, Fund and the World Bank. To maintain the relevance of www.brookings.edu/papers/2008/09_global_governance_ these institutions, emerging market and poor countries rieffel.aspx. must be given a more prominent say in running them and institutions may make them more effective, it will also be necessary for the U.S. to support steps to increase their capital bases to enable them to respond more effectively to instances of global financial turmoil.

6 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 2 Setting the Right Green Agenda

By Warwick McKibbin, Adele Morris and Peter Wilcoxen

limate and energy issues will be some of the most should pursue a climate protection strategy that cuts emissions urgent challenges facing the next U.S. president. while protecting the American economy—no easy balance. C What follows is a sketch of one approach that would minimize These issues will need immediate attention to create the economic burden while spurring new technologies a policy framework that will enable timely reductions and adaptation, as well as setting a course for a stabilized atmosphere. in greenhouse gas emissions while minimizing the economic burden on American working families. The Global Context Much of the potential for effective U.S. government action At the heart of the international debate on climate policy lie two depends on the ability of the next president to develop a key tensions. First is the tension between the worldwide need coherent executive branch strategy, deftly navigate a complex to avoid damaging disruption to the Earth’s climate and the congressional landscape, and ensure that American priorities critical importance of reducing global poverty. Analysts agree help shape the post-Kyoto international climate that the world’s already-heavy dependence on fossil fuels is agreement, despite weakened U.S. credibility. Implementing only likely to worsen if developing countries continue to stoke an effective and efficient domestic cap-and-trade program will their rapid economic growth in traditional carbon-intensive require strong leadership and intense focus, not only to make ways. The second tension is over the distribution of costs and complex trade-offs across potential legislative features but also the competitive implications of mitigating greenhouse gas to withstand the onslaught of pressures for special provisions emissions. China and India argue not only that they cannot that has plagued recent bills in the U.S. Senate. reduce emissions without technology and financing from rich countries but also that developed countries should act first Given the enormous economic implications of transforming because they are responsible for the buildup of greenhouse gases the U.S. energy system and the environmental necessity for in the atmosphere. And though the members of the European reducing greenhouse gas emissions, the new administration Union and most other developed countries are unlikely to

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 7 meet their targets, they have tried to take action by ratifying as carbon capture and storage) or preferred sectors also the Kyoto Protocol and taking steps to implement it. In sharp raises costs by distorting investment away from least-cost contrast, the U.S. rejected Kyoto and has taken no regulatory solutions and forgoing revenue recycling. The key goal action at the federal level. As a result, the U.S. lacks credibility must be to create a clean, clear price signal with minimal in international negotiations and will find it difficult to prevail bureaucracy. until it makes a serious domestic commitment to action. >> Create incentives to sustain the program. Firms will Therefore, despite dramatic recent growth in greenhouse gas only invest in new technologies if they think the price emissions by developing countries and projections for more, on greenhouse gas emissions will endure and grow, so the spotlight will be on the next president of the United States strong long-run incentives to keep the program intact are to reengage in the United Nations Framework Convention important. A variety of mechanisms could be used, ranging on Climate Change process and push for serious domestic from creating multiple-year emissions allowances to emissions reductions. Clearly, the next president will need to auctioning allowances that won’t be valid until future years. act; the question is how. In either case, creating future emissions rights that can be traded (but not used) today will create a constituency of permit owners with a strong financial interest in continued The Challenge climate protection, and could bring in extra revenue early Both major-party candidates for U.S. president have promised on to fund research. a cap-and-trade system for the control of greenhouse gas emissions with an eye toward reductions by 2050 of 60 >> Control the risk of inadvertent stringency and laxity to 80 percent relative to 1990 levels. Long-run objectives in the cap. Chances are good that the trading price of notwithstanding, the new president will need to focus more allowances won’t be exactly what lawmakers expect when on getting the broad structure of the cap-and-trade system they set the cap. If the allowances price is too high, right and less on aggressive reductions that would undermine consumers and the economy could suffer enough that the support for it. The next president will need to proceed policy would be repealed. If it’s too low, investors would judiciously to establish sound institutions, create incentives have little incentive to look for cost-effective reductions and for new technology and build an effort that can endure for could miss greenhouse gas emissions targets. This could be generations. Here’s how to do it: avoided by establishing an annual preset allowance price range that would allow firms to buy extra allowances at the ceiling price. The best means to impose a price floor would America’s Opportunity depend on how the program sells or otherwise allocates >> Use the cap-and-trade program to set a modest but allowances. Alternatives, such as a committee that can growing price on carbon and other greenhouse gases. intervene at its discretion, could do more harm than good Moving to a low-carbon economy will require large long- by increasing uncertainty in the allowance market. term investments by all sectors of the economy. To encourage those investments, the government should provide clear, >> Sell allowances and recycle the revenue. Pricing carbon predictable long-term payoffs for them through a modest raises the prices of goods and services more broadly, but credibly increasing price for emitting greenhouse gases. effectively reducing the value of working families’ wages, The price incentive can efficiently shift the economy to a which are already subject to payroll and income taxes. low-greenhouse gas future. Starting modestly will reduce The cost of this important “tax interaction effect” to the costs by allowing new technologies to develop before steep economy could be even higher than the direct cost of emissions cuts kick in. abating greenhouse gas emissions. The good news is that using revenue from allowances sales to lower other taxes (or >> Keep it simple. Though it would be tempting to offer a the federal deficit) can offset the burden significantly. “comprehensive energy plan,” favor certain sectors and technologies, introduce goals other than climate protection >> Make serious investments in basic science and in and create new institutions, the simpler the better—both technology research and development. Higher carbon now and in the long run. Policies such as low carbon fuel prices will provide strong incentives for private companies standards, biofuel mandates, and renewable portfolio to accelerate development technologies that are nearly standards significantly raise costs by dictating how the ready for the market. However, basic research on the cap must be met. They can also introduce unintended underlying science and engineering will also be needed consequences such as deforestation and higher food prices. and will not be undertaken by the private sector alone. Giving free allowances for certain kinds of reductions (such Funding that research should be a top priority for the

8 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT federal government. Priority research areas should include Want to Read More? low-greenhouse-gas technology; large-scale carbon capture Antholis, William. “Lessons for Governing Global Climate and sequestration; better means to adapt, such as improved from World Trade,” as prepared for Brookings forum crops and water management; and basic climate science to “Climate Change, Trade and Competitiveness: Is a Collision reduce uncertainty around the problem. In addition, much Inevitable?” on June 9, 2008, www.brookings.edu/events/ more research is needed on geoengineering, which could be 2008/~/media/Files/events/2008/0609_climate_trade/2008_ needed if the climate begins to change rapidly. antholis.pdf >> Protect the poor. All households will gradually feel the Brainard, Lael, Abigail Jones, and Nigel Purvis, eds. pinch of the carbon price, but the poor will be hit the Development in the Balance: How Will the World’s Poor hardest and soonest. The government should use some Cope with Climate Change? Brookings Institution Press, of the proceeds from allowance sales to benefit the poor, forthcoming. for example with lump-sum rebates, but it will need to recognize that every dollar used for redistribution will raise Brainard, Lael, and Isaac Sorkin, eds. Climate, Trade the total cost of the program by forgoing the benefits of and Competitiveness: Is a Collision Inevitable? Brookings revenue recycling. Institution Press, forthcoming. >> Use domestic action to promote binding commitments Hamilton Project. “A Carbon Tax Swap to Mitigate Global by major developing countries. Initially, the U.S. Climate Change.” Brookings Hamilton Project Policy should introduce its domestic cap-and-trade program Brief 2007-12, 2007, www.brookings.edu/~/media/files/rc/ unconditionally. As the U.S. carbon price ramps up, the papers/2007/10carbontax_metcalf/10carbontax_metcalf_ U.S. should parlay its domestic efforts into commitments pb.pdf. by all major economies to reduce their greenhouse gas emissions, even relative to baseline projections. Although Hamilton Project. “A U.S. Cap-and-Trade System to Address the competitiveness of U.S. industry vis-à-vis China is Global Climate Change.” Brookings Hamilton Project Policy a potent political issue, domestic climate policies would Brief 2007-13, 2007, www.brookings.edu/~/media/files/rc/ have little effect on most industries that are exposed to papers/2007/10climate_stavins/10climate_stavins_pb.pdf. international competition. Apart from a few sectors, such as aluminum refining, energy accounts for only a small McKibbin, Warwick J., and Peter J. Wilcoxen. Climate share of the cost of most manufactured goods. Indeed, Change Policy after Kyoto: A Blueprint for a Realistic most energy is used for nontraded goods and services, Approach. Brookings Institution Press, 2002. such as local transportation and electric power generation. Introducing tariffs or border adjustments on imported McKibbin, Warwick J., and Peter J. Wilcoxen. “A Credible goods to compensate for differences in climate policies Foundation for Long-Term International Cooperation on among trade partners would be far more trouble than it Climate Change,” in Architectures for Agreement: Addressing would be worth. It would be administratively complex Global Climate Change in the Post-Kyoto World, ed. Joseph and impede trade, while producing very little protection Aldy and Robert Stavins. Cambridge University Press, 2007. for domestic industries and having little effect on the so- called leakage of emissions reductions to countries with low McKibbin, Warwick J., Peter J. Wilcoxen, and Wing Thye energy costs. Woo. Preventing the Tragedy of the CO2 Commons: Exploring China’s Growth and the International Climate Framework. Brookings Global Working Paper 20, 2008, www.brookings. edu/papers/2008/07_china_climate_change_woo.aspx.

Sandalow, David. “Climate Change: Beyond Bali,” 2007, www.brookings.edu/opinions/2007/1217_climate_change_ sandalow.aspx.

Talbott, Strobe, and William Antholis. “Tackling Trade and Climate Change: Leadership on the Home Front of Foreign Policy,” 2007, www.brookings.edu/papers/2007/02trade_ antholis_Opp08.aspx.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 9 3 Exercising Smart Power

By Lael Brainard and Noam Unger

he spectacular failure of the U.S. financial regulatory The Global Context Tsystem is just the latest in a series of blows to In a world where remote threats can rapidly metastasize America’s standing in the world over the past eight into emergencies, the fight against global poverty has become a fight of necessity—because national security years—which are particularly troubling against the demands it no less than American morality. The U.S and backdrop of the emergence of new powers, notably the international community can and should do more to address key challenges—including fighting HIV/AIDS and China and India as well as resource-rich Russia and other key infectious diseases while strengthening public health Brazil. As the new U.S. administration faces the critical systems; boosting productivity in food production; and, more generally, improving the accessibility and quality of education, challenge of restoring American leadership, it has a especially for girls; targeting poorly governed and conflict- unique opportunity to readjust how America projects its prone states; and helping to mitigate and build resilience to climate change. From the world stage where leaders adopted global power. Friends and allies are more important than the UN Millennium Development Goals to the local stage ever on today’s interconnected globe, particularly as it where individuals send text messages to the ONE campaign faces sustained threats from climate change, poverty in support of antipoverty programs, the basic goal is clearly understood: to help the poor lift up their lives and with them and pandemics as much as from terrorism. To strengthen the sustainability and stability of the planet. its global influence, America must present a different face to the world, one that burnishes the country’s smart America’s engagement in the fight against global poverty harkens back to the best traditions of the Marshall Plan, the founding of power through more effective aid and stronger civilian, the Bretton Woods institutions and John F. Kennedy’s Alliance volunteer and private sector engagement. for Progress. But it also appeals to the best instincts of a new

10 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT generation of Americans who are engaged in the fight against the average project size appears to be shrinking, implying a global poverty as never before. Individual donations from the growing fragmentation of aid and underscoring the need to U.S. to the developing world have surged to roughly $26 billion improve global, as well as U.S., systems. a year, exceeding official development assistance, and more than 50,000 Americans volunteer their time overseas each year. Making U.S. aid efforts not just bigger but also Americans’ consciences, hearts and faith demand that the U.S. smarter—through better coordination, planning and aid tackle deprivation because it is the right thing to do. But helping administration—should be a primary objective for the next the poor gain access to shelter, medicine, sustenance, education administration as it addresses global poverty. and opportunity does more than make Americans feel good; it also makes the world feel good about America. When America leads in helping the poor lift up their lives, it enhances its own America’s Opportunity influence and authority in the world community—building The next U.S. president will have the opportunity to: support for its interests in other areas. >> Elevate development assistance to equal stature and independent standing alongside defense and The Challenge by aligning resources and capabilities with goals. A America’s aspirations and aid dollars will surely exceed its Cabinet-level voice for development would serve as a impact on the ground unless and until it refocuses its foreign bold commitment to ensure against the subordination of assistance strategy, modernizes its aid apparatus and builds long-term investments in democratization, development its civilian capability. The urgent demands of postconflict and poverty alleviation to short-term political objectives. reconstruction in Iraq and Afghanistan and humanitarian Instead of the 50 units currently managing its aid programs, disasters have led to a faster rate of expansion of foreign the U.S. should have one operationally capable, integrated assistance dollars in the last seven years than at any point agency. Instead of the 50-odd objectives these units pursue, since the Cold War. But instead of modernizing the U.S. aid the U.S. should have no more than five strategic aid infrastructure left from the Cold War era, the George W. Bush priorities: fighting poverty; supporting capable, accountable administration responded to each new global challenge by states that advance human development and security; creating new ad hoc institutional arrangements alongside the and countering security, humanitarian and transnational old ones, such as the President’s Emergency Plan for AIDS threats. This focus is critical for maintaining broad support Relief, the President’s Malaria Initiative, the Millennium for expanded assistance. Instead of stove-piped trade, aid Challenge Corporation, and the State Department’s Office and debt policies, the U.S. should have a high-level policy of the Director of Foreign Assistance. Meanwhile, by default coordinator in the White House and integrated task forces rather than design, the Defense Department has been taking in the field. on a growing role, and it now accounts for one-fifth of U.S. official development assistance. >> Strengthen U.S. civilian capabilities to assist weak and failing states by bolstering civilian capacity for conflict With all this recent U.S. institution building, the federal prevention, stabilization and reconstruction both inside government’s executive branch now has 50 separate units the government and in reserve; increase the seniority of that share responsibility for aid planning and delivery, with White House coordination; and ensure linkages between a dizzying array of 50 objectives ranging from narcotics interagency planning and foreign assistance operations. eradication to biodiversity preservation. Different agencies pursue overlapping objectives with poor communication and >> Showcase the spirit of American generosity by doubling coordination. At best, this lack of integration means that the the number of Americans who volunteer overseas by United States is failing to take advantage of potential synergies; 2010. The U.S. should do this by revitalizing and expanding at worst, these disparate efforts are working at cross-purposes. its established programs that encourage volunteer service Meanwhile, at a time when aid dollars have grown rapidly, abroad. Also, with a small investment and by engaging key the number of civilians with the training and experience to players outside government, the U.S can and must create effectively implement assistance programs has diminished innovative new approaches that support the myriad global sharply. As a result, the impact of American foreign assistance service, cultural and educational exchange opportunities is falling short of the value of the aid dollars expended—which provided by America’s vibrant faith-based and private remains unmatched among bilateral donors. volunteer organizations, universities and businesses. Finally, efforts supported by the U.S. government that are related Internationally, as Brookings expert Homi Kharas has shown, to international service and volunteering should be drawn the average number of donors per country is growing, while together under a Corporation for International Study and

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 11 Service, a globally oriented analog to the existing domestic Want to Read More? Corporation for National and Community Service. Brainard, Lael. “Foreign Assistance: Advancing National Security, Interests and Values.” Testimony to the U.S. House >> Adapt to and leverage the new ecosystem of global of Representatives Committee on Foreign Affairs, April 23, development players—including multinational corporations, 2008, www.brookings.edu/testimony/2008/0423_foreign_ major individual philanthropists, high-profile advocates and assistance_reform_brainard.aspx. especially the vocal and energized public working through grassroots and faith-based networks—that are fundamentally Brainard, Lael, ed. Security by Other Means. Brookings redefining the international development community. The Institution Press, 2007. next administration should create platforms and flexible funding mechanisms within the U.S. foreign assistance agency Brainard, Lael, and Derek Chollet, eds. Global Development to systematically, proactively encourage multistakeholder 2.0: Can Philanthropists, the Public, and the Poor Make collaboration; replicate and scale up successful innovations; Poverty History? Brookings Institution Press, 2008. and adopt common mechanisms for evaluating results and enhancing accountability. Brainard, Lael, and Derek Chollet, eds. Too Poor for Peace? Global Poverty, Conflict and Security in the 21st Century. >> Help developing countries fully integrate their climate Brookings Institution Press, 2007. adaptation activities into their broader national programs for reducing poverty and creating wealth. The Caprara, David, Harris Wofford, and John Bridgeland. “Global next U.S. administration can both redirect bilateral and Service Fellowships: Building Bridges through American multilateral funding to projects that are carbon neutral and Volunteers.” Brookings Policy Brief 160, 2008, www.brookings. help align development outcomes with climate resilience to edu/papers/2007/03globalgovernance_caprara.aspx. minimize the threat of promoting climate maladaptation that inadvertently impedes human development or Kharas, Homi. “Measuring the Cost of Aid Volatility.” development programs that result in greater vulnerability Working Paper 3, Brookings Wolfensohn Center for to climate change. Development, 2008, www.brookings.edu/~/media/Files/rc/ papers/2008/07_aid_volatility_kharas/07_aid_volatility_ kharas.pdf.

Kharas, Homi. “Trends and Issues in .” Working Paper 1, Brookings Wolfensohn Center for Development, 2007, www.brookings.edu/papers/2007/11_ development_aid_kharas.aspx.

Quigley, Kevin, and Lex Rieffel. “Ten Times the Peace Corps: A Smart Investment in .” Brookings Global Views 5, 2008, www.brookings.edu/papers/2008/09_peace_ corps_rieffel.aspx.

Unger, Noam. “Foreign Assistance Reform: Then, Now and Around the Bend,” Monday Developments (InterAction), July 2007, www.brookings.edu/articles/2007/07foreignassistan ce_unger.aspx.

12 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 4 Reimagining Global Trade

By Paul Blustein

y some measures, U.S. trade policy has been a Since the collapse in July 2008 of the latest effort to reach a Doha Round agreement, there have seemed scant prospects blizzard of activity and achievement during George B that a deal will materialize anytime soon—and certainly not W. Bush’s administration. In 2001, the United States one that fulfills the initial promise of providing massive trade played a crucial role in launching the Doha Round of global advantages for developing countries. Another cherished goal of the Bush White House, the creation of a Free Trade Area of trade talks. In 2002, the White House won congressional the Americas, has been stalled since 2003. As for the bilaterals, authority to negotiate new trade agreements. And in the countries with which the Bush team struck agreements are relatively paltry markets for U.S. . Taken together, the subsequent years, Washington has secured bilateral free nations with completed deals account for less than 7 percent trade accords with numerous countries, including Chile, of total U.S. goods exported; if the pending accords with , South Korea and Panama are included, the figure Singapore, Jordan, Australia, Morocco, Oman, Bahrain, is still only about 11 percent of all exports. (And that’s just a five Central American nations and the Dominican sliver of the total economy; exports accounted for less than 8 Republic. Negotiations for free trade agreements with percent of U.S. GDP in 2007.)

three other countries—Colombia, South Korea and Moreover, although the administration’s strategy was to Panama—have been completed by the administration use bilaterals as building blocks to regional and ultimately global trade accords, this approach, known as “competitive but are tied up in Congress. However, these initiatives liberalization,” has failed. Meanwhile, the administration’s have produced very limited benefits, and they have left authority to negotiate new pacts expired in June 2007, and amid continued division in Congress over how trade deals the global trading system in an increasingly parlous state should be structured, that authority is unlikely to be restored for the next president and his trade representative. in the near future. The campaign vows by Sens.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 13 and to renegotiate NAFTA were emblematic would have mainly required member countries to lower their of the antitrade mood in the American body politic. “bound” tariffs—that is, their legal maximums—to levels that are still above the “applied,” or actual, rates. More important, the round in its current form would do almost nothing about The Global Context several major trade-related issues that have arisen in recent In the midst of this global situation, U.S. trade has not flagged years. One of these is the food crisis, which has prompted in monetary terms. On the contrary, imports have played a many nations to impose limits on crop exports. Another is crucial role in recent years in keeping inflation low, and exports climate change; some countries are moving toward imposing have been a major factor in preventing the U.S. economy from “green tariffs” based on the carbon content of imported goods, falling into recession. which may provoke challenges in WTO tribunals.

But the system that undergirds global commerce will be imperiled if its troubles are not addressed. In particular, the America’s Opportunity woes of the Doha Round raise profound concerns about the The new U.S. administration should make it clear from ’s ability to continue as the main the outset that its trade policy will be multilateral in focus; rule writer for global trade. For all its flaws, the WTO is a this can—and should—be coupled with a shift away from crucial lynchpin of stability—its rules keep a lid on member bilateralism: countries’ import barriers; and by adjudicating trade disputes among member nations, it helps keep those disputes from >> Shoring up support for trade: Perhaps most important flaring into trade wars. of all, the new president must shore up support for trade, both in Congress and in the public at large; otherwise, The WTO’s centrality was already in some doubt because of no new trade agreements of any kind may be possible. the proliferation in recent years of bilateral and regional trade This will entail bridging gaps on Capitol Hill over the key agreements (fueled partly by Washington’s enthusiasm); more issue of whether trade agreements must contain enforceable than 200 of these accords are currently in force. To be sure, the standards for workers’ rights and environmental protection. WTO is hardly going to disintegrate overnight. But the more But much stronger steps will also be required on the dysfunctional and irrelevant the WTO appears, the greater domestic front, to expand the social safety net and health the danger that its authority will atrophy to the point that its care. Mitigating Americans’ legitimate worries about the member nations start to flout their commitments and ignore disastrous impact of job losses is essential to turn the debate its tribunals’ rulings. away from NAFTA’s revision and toward enhancing the system that has underpinned the expansion of global trade for the past 60 years. The Challenge The nations of the world have an enormous collective interest >> Breathing new life into the Doha Round: The new in ensuring that the multilateral trade system remains vibrant, president will have a historic opportunity to breathe new and the best way to do that is to forge a credible, ambitious life into the Doha Round by proposing to broaden the Doha Round agreement. The possibility of an accord on the negotiating agenda to include issues such as the food crisis main elements of the round before the end of 2008 cannot and climate change. It is conceivable, of course, that such be ruled out, because a number of key leaders and trade an approach will encounter such stiff opposition from policymakers—President Bush foremost among them— other nations that it will prove impractical; if so, the would love to burnish their legacies with such an accord. administration should not turn to bilaterals and regional But the chances for a quick deal are remote, given the vast deals as an alternative but instead should pursue agreements differences between key players—the U.S., China and India in in particular sectors (such as services) under WTO auspices particular—over the central issues of how much to liberalize with countries that are willing to liberalize. trade in (that is, cutting both tariffs and subsidies). Overcoming these differences, and facing down powerful >> Proposing a moratorium on bilateral trade agreements: interests, will be a daunting task, especially for democratic In addition, the president could propose a moratorium on governments. bilateral trade agreements, a step that would be welcomed by many poor countries, which fear being marginalized in Beyond the gaps in position among big powers, the Doha an increasingly splintered world of trade. Round is suffering from the staleness of its agenda. Its ambition has already been whittled away. The deal on the table in July wouldn’t have appreciably reduced current trade barriers; it

14 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT Want to Read More? Blustein, Paul. “Doha Trade Talks Collapse: What’s Next for Global Trade?” 2008, www.brookings.edu/ opinions/2008/0820_trade_blustein.aspx.

Blustein, Paul. “Trade Pacts Run Amok?” World Policy Journal, vol. 23, issue 2 (August 2008), www.brookings.edu/ articles/2008/08_trade_blustein.aspx.

Bown, Chad, and Rachel McCulloch. Trade Adjustment in the WTO System: Are More Safeguards the Answer? Brookings Global Working Paper 7, 2007, www.brookings.edu/ papers/2007/06trade_bown.aspx.

Brainard, Lael. “America’s Trade Agenda: Examining the Trade Enforcement Act of 2007. “Testimony Before the Senate Finance Committee,” May 22, 2008, www.brookings. edu/testimony/2008/0522_trade_brainard.aspx.

Brainard, Lael. “New Economy Safety Net: A Proposal to Enhance Worker Adjustment Programs,” Democracy Journal, Spring 2008, www.brookings.edu/articles/2008/spring_ economic_security_program_brainard.aspx.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 15 5 Navigating China’s Rise

By Wing Thye Woo

hina is growing rapidly through its outward orientation workers from low-productivity agriculture to higher-produc- tivity, labor-intensive manufacturing. About half the country’s and engagement with the world economy. Its C exports are produced by non-Chinese firms and joint ventures growth has provoked anxiety in the United States and located in these enclaves; and wages have grown unevenly and much more slowly than productivity in many areas, reflecting concerns about its perceived unfair trade practices. The China’s enormous amount of surplus labor from rural areas. next U.S. president should enact policies that reduce the As China’s economy has grown, so has its engagement with sources of anxiety, address trade practices, strengthen and integration into the Asia-Pacific region through its “smile U.S. competitiveness, and develop a sustained strategy diplomacy”—it has settled regional territorial disputes, abjured the use of force in Southeast Asia, and actively promoted for working with China on international economic issues. and supported regional cooperation. A growing network of regional political agreements and arrangements place China at the center—ranging from the ASEAN + 3 agreement at The Global Context the head-of-state level (the three additional participants being China is pursuing a classic -led growth strategy, hinging China, , and South Korea) to a dizzying array of regional on two features: foreign demand to fuel output growth and and bilateral trade and monetary arrangements. foreign direct investment to upgrade its technology and expand its export capacity. Because of the massive scale of China’s On the international scene, Chinese officials have pursued economy, this outward-oriented growth is generating tsunami- deft economic diplomacy, winning over potential adversaries. like waves affecting the farthest reaches of the global economy. Despite some stark differences in the Doha Round negotiations for the World Trade Organization relative to developing China’s key growth mechanisms have been extensive investments countries like India, China has worked with other rising powers in export-oriented enclaves and a massive redeployment of to shape these negotiations’ agenda. Though the chronically

16 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT large balance-of-payments surpluses of China indicate an The adjustment pains reflect not only the integration of China undervalued exchange rate, it has managed to deflect serious but also that of India. Together, these two huge nations are interference by the International Monetary Fund. adding 1.2 billion lower-wage workers to the global economy. With lagged adjustment of “capital,” this puts downward However, in light of the experience of dealing with Japan’s pressure on the wages of similarly skilled workers elsewhere— trade surpluses in the 1980s, it must be recognized that the while increasing corporate profits and the earnings of other adjustment of the bilateral U.S.-China exchange rate alone is complementary inputs. not a silver bullet that would eliminate U.S. external imbalances. A huge appreciation of the renminbi—unaccompanied by a At the same time, the large U.S. trade deficit and China’s rapid large, generalized appreciation of other Asian currencies— rise have sparked accusations that China’s economic strategy would significantly reduce only the bilateral U.S.-China is unfair. The U.S. goal in promoting China’s accession to the trade imbalance but not the U.S. overall trade deficit because WTO in 2001 was to bind China to increasing responsibility imports from third countries would replace imports from in the international arena. Yet China has often failed to live up China. A drastic decline in the U.S. overall trade deficit would to its WTO commitments and rules on intellectual property, require policy actions on a broad front in both China and the export subsidies and import deterrents. The U.S. Department U.S.—for example, budget deficit reduction in the U.S. and of Homeland Security reports that nearly 70 percent of financial sector restructuring in China. products seized for infringing on intellectual property rights originate in China. Chinese firms that meet specified export China’s sustained rapid growth, along with that of India, has performance targets are eligible for tax rebates. And firms that contributed to a big jump in commodity prices. The higher choose Chinese-made equipment over imported equipment costs of inputs have two negative effects: reducing profits and also qualify for tax rebates. hence lowering the supply of the final goods; and causing the prices of final goods to rise, thus preventing profits from China’s growing influence in the Asia-Pacific region has been absorbing the entire cost increase. This stagflationary (inflation- matched by America’s neglect of its important regional allies. amid-contraction) situation has confronted the central banks The U.S. has neglected the 21-nation Asia-Pacific Economic in Europe and the U.S. with the difficult choice of contracting Cooperation forum’s economic agenda; as a result, regional credit to blunt higher inflation or of expanding credit to offset policymakers have learned to bypass the United States in favor reduced production. This dilemma is now complicating efforts of Asia-only forums. And while the U.S. has devoted its energies to meet the new challenge of creating additional liquidity to to negotiating bilateral free trade agreements with selected East calm the financial turmoil that started with the bursting of the Asian countries, it has neglected the ASEAN + 3 approach that U.S. subprime mortgage bubble in February 2007. increasingly dominates the region’s economic architecture.

Inevitably, weakened demand in the U.S. and Europe is being China has now overtaken the U.S. as the biggest emitter of carbon transmitted to suppliers in Asia and elsewhere, in turn slowing dioxide in the world. And China’s greenhouse gas emissions down their growth, and hence moderating the commodity price will continue to grow faster than U.S. emissions because of boom. The lesson is that economic globalization has created China’s continuing industrialization and growing use of coal as such complex interdependence and new powerful actors that a fuel. Any international agreement on controlling emissions the guardianship of global prosperity has become a multilateral would fail without the full participation of China and India. enterprise, in which widening cooperation (for example, in trade Because China is responsible for only a tiny part of the stock deregulation, financial flows and environmental commons) is of atmospheric carbon dioxide, and its per capita emissions paramount for avoiding unintended negative side effects. are only a quarter of America’s, the notion of “common but differentiated responsibility” has to be the guiding principle in the U.S. bargaining stance in global negotiations on climate change. The Challenge China’s growth has been accompanied by growing anxiety in the United States. While U.S.-based multinationals rush America’s Opportunity to establish a foothold in China’s growing market and U.S. The next U.S. president will have the opportunity to: consumers stock up on “made in China” merchandise, American manufacturing workers, small business owners >> Enact policies that address domestic anxiety about and politicians have become anxious about this latest wave how American workers will fare in an increasingly of globalization. Though fears of a permanent loss of U.S. globalized economy. The president should prioritize comparative advantage are overblown, concerns about an national investments in key areas that foster American unequal distribution of the benefits and pains are not. innovation and competitiveness that have been neglected

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 17 in recent years—science and technology infrastructure, and more muscular surveillance capacity that might lead to education and training programs. The president should meaningful currency realignment. The U.S. should also update the social insurance system to reduce the pain of actively sustain a high-level multiagency mechanism as a increased worker dislocation. The U.S. should provide vehicle for bilateral engagement across a range of issues. protections for health insurance and pensions, improve the unemployment insurance system and implement a wage >> Understand that one key to avoiding a clash with China insurance program to minimize the burden on workers over how to prevent an environmental Armageddon facing job transitions. is to devise win-win technological solutions to the challenge of climate change. The U.S. should take the >> End the chronic external imbalances of the U.S. and lead in establishing an international clean energy research China. Because there would be considerable disagreement on consortium to create synergy among the national efforts how to encourage a change in China’s policy of undervalued to accelerate the emergence of renewable energy and currency and on the degree of misalignment, the U.S. should clean coal technology. This consortium would coordinate use coordinated multilateral pressure through the International and fund experiments on new clean energy technologies Monetary Fund and the Group of Seven—along with bilateral in China because China, on its own, would have little engagement—far more effectively. The U.S. should also engage incentive to develop these new technologies, which can on a technical level with China to support efforts to accelerate be easily appropriated by other countries. Because China the development of nonstate financial institutions to fully is building one power plant each week to sustain its high intermediate savings into domestic investments, and to reduce rate of economic growth, it is the ideal location for these the excessively high savings rate—both of which would reduce experiments on how to harness alternative fuels, burn coal China’s external surplus. Because trade imbalances reflect cleanly, and scale up prototype green power plants. economic conditions in both countries, it is fundamental to recognize that improving the competitiveness of the U.S. economy and putting the U.S. fiscal house in order are Want to Read More? fundamental to restoring U.S. growth and its trade balance. Brainard, Lael, and Wing Thye Woo. “Navigating China’s Mutual recriminations (China bashing) and the obsession Rise: Develop a Sustained, High-Level Trade Strategy,” 2007, with a single silver bullet (exchange rate adjustment) would www.brookings.edu/papers/2007/0228chinasrise_Opp08.aspx. only accentuate the tensions over trade imbalances. Instead, the optimum solution will be based on mutual actions on McKibbin, Warwick J., Peter J. Wilcoxen, and Wing Thye multiple fronts. Woo. “Preventing the Tragedy of the CO2 Commons: Exploring China’s Growth and the International Climate >> Emphasize China’s obligations to enforce WTO Framework.” Brookings Global Working Paper 20, 2008, rules on the protection of intellectual property and www.brookings.edu/papers/2008/07_china_climate_change_ on the creation of a level economic playing field. The woo.aspx. next administration will need to employ a multipronged approach, combining engagement and technical assistance Song, Ligang, and Wing Thye Woo, eds. China’s Dilemma: with the use of dispute resolution mechanisms to enforce Economic Growth, the Environment, and Climate Change. rights in a handful of consequential cases. Brookings Insitution Press, 2008.

>> Pursue a concerted strategy of shaping international Woo, Wing Thye. “The Structural Nature of Internal and structures and arrangements to handle China’s rise. The External Imbalances in China,” Journal of Chinese Economic U.S. should woo its natural allies in the Asia-Pacific region and Business Studies, vol. 4, no. 1 (February 2006), www. with parallel interests, rather than abandoning the field to brookings.edu/papers/2005/1229globaleconomics_woo.aspx. China’s smile diplomacy, as in the past five years. The next president should mount a concerted diplomatic effort to Woo, Wing Thye. “What Are The High Probability accelerate and deepen involvement in broader regional Challenges to Continued High Growth in China?” 2007, integration initiatives, such as those centered on the Asia- www.brookings.edu/papers/2007/0522globaleconomics_ Pacific Economic Cooperation forum and ASEAN + 3. woo.aspx.

>> Take a leadership role—given U.S. membership in the International Monetary Fund—in brokering expanded IMF “chairs and shares” for China and other countries commensurate with their economic heft in return for a

18 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 6DECIPHERING “Russia, Inc.”

By Clifford G. Gaddy

or more than eight years Russia, has benefited from The Global Context Fthe global commodities boom as have few other Seventeen years into its transition from central planning to a free market economy, Russia presents a conflicting picture. countries in the world. Prudent management of its oil It has the second-largest number of Forbes billionaires after and gas windfall has resulted in large fiscal and financial the U.S. At the same time, the structure of its economy continues to bear a strong imprint from its Soviet past. The surpluses. At home, welfare and public and private production structure—the type and size of factories and wealth have risen dramatically. For the world, Russia has the location of entire cities—is highly unnatural from a market standpoint. Its management model is also distinct: emerged as a major market for consumer and investment a combination of companies operated by private owners goods. As 2008 draws to a close, however, the outlook but under the watchful eye of the closed inner circle of the country’s political leadership. The description of the Russian for Russia has begun to dim. Oil and gas output growth economy as “Russia, Inc.” is apt. has slowed and even contracted. The Russian stock market has suffered from the combined drop in oil prices As a potential market, as an energy supplier and as a major financial power, Russia now occupies a prominent place in the and the global credit crunch. Geopolitical tension since global economy. Eight years of annual GDP growth exceeding 7 percent have made Russia’s 140 million consumers, still with Russia’s invasion of neighboring Georgia in early August pent-up demand from decades of shortages under communism, 2008 has led to calls to exclude Russia from the global one of the world’s most attractive markets. And as the world’s biggest producer of oil and natural gas, Russia plays a crucial economy. All these developments threaten Russia’s role in global energy security. Finally, Russia now holds the potential contributions to the global economy. world’s third-largest foreign currency reserves.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 19 The Challenge primarily of how to interact with, not act upon, the Russian economy. A few guidelines in that effort might include: The challenge for the next U.S. president and U.S. policymakers is to ensure that Russia can realize its potential >> Support Russia’s full role in the global economy: To as a market, that it can continue to supply oil and gas to show that it is serious about supporting Russia’s equal the world economy and that it will remain committed to participation in the global economy, the U.S. should global economic integration. This is especially difficult in the repeal the Jackson-Vanik Amendment, a piece of Cold wake of the global financial crisis and the geopolitical tensions War legislation that denies most-favored-nation trade stemming from the Georgia invasion. The U.S. challenge has status to countries with nonmarket economies that restrict several dimensions: emigration rights. >> The market challenge: The U.S. share of the Russian >> Insist that Russia play by the rules: While the U.S. market has traditionally been small. The potential for encourages Russia to integrate into the global economy, growth is vast, but companies doing business in Russia face it must at the same time insist that Russia play by the a difficult business climate permeated by corruption and rules. But America needs to be scrupulous in applying all overregulation. rules fairly; they should not be applied in a discriminatory fashion as a political lever. >> The energy supply challenge: The strong growth of Russian oil production in the past decade was an >> Encourage U.S. investment in and trade with Russia: important moderating force on oil prices globally. Russia’s The U.S. government should strongly encourage current decline is therefore a cause of general concern for American firms to invest in and sell to Russia, despite consumers worldwide. Russian oil is high-cost oil, and thus the current difficult investment climate. But the U.S. will all investment in future supply is subject to great risk from have to make it clear that it can do little as a government price volatility. Russia is likely to continue to underinvest to directly change that climate. Ultimately, the burden unless the West can help solve the fundamental problem rests with the businesses. for the Russians: large risk. >> Deal seriously with Russia on the energy issue: This >> The financial challenge: Russia is third only to China urgent challenge will require sustained attention at the and Japan as a foreign holder of Western—mainly U.S.— highest level on the U.S. side. It is an illusion to think that government securities. These massive funds represent a Russians will “need” to turn to the outside world for help transfer from Western consumers to Russia’s state coffers. simply because their output of oil and gas is stagnating America would be better off if these funds were recycled or declining. There is a real danger that the enormous back into its economy in the form of equity investments. costs and risks of massive new energy investment will cause the Russians to postpone critical decisions for too long. >> The geopolitical challenge: In the desire to punish Russia The U.S. administration must work with the Russians and for its invasion of Georgia in August 2008, some Western the Europeans to find risk-sharing mechanisms. Political policymakers have proposed using economic levers such as distrust will only raise the West’s risk premium. blocking Russian accession to the World Trade Organization or restricting trade and investment flows. Such an approach The new U.S. administration must resist the temptation could damage the global system itself. to use integration with the global economy as a carrot that can then be withdrawn as a stick—this would undermine America’s Opportunity the very premise that greater mutual economic dependency promotes both prosperity and security. Thus, it would be Russia’s economy operates according to a model that counterproductive to try to make Russia pay for political remains distinctively different from that of other leading behavior by blocking its accession to the WTO, expelling nations. It is not only in Russia’s but also our own interest it from the Group of Eight or restricting its trade and that its economy evolve toward the international norm. The investment flows with West. It would hurt America more most realistic approach to achieve that goal is to promote than the Russians, and it would risk leaving the U.S. with a the further integration of Russia into the global economy. Russia that is more, not less, difficult to deal with. The West Direct influence on Russian economic policymaking is out has two choices for Russia: Keep it out or bring it in. If it is of the question. In the 1990s, there was no shortage of bold pushed out and kept out, it will have no stake. Nothing good American interventionist plans and programs to reform the will happen inside Russia as a result of less interaction with Russian economy. Today, American policymakers must think the outside world.

20 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT Want to Read More? Gaddy, Clifford G. and Barry W. Ickes. Russia’s Addiction: The Political Economy of Resource Dependence. Brookings Institution Press, forthcoming.

Gaddy, Clifford G. and Fiona Hill. The Siberian Curse: How Communist Planners Left Russia Out in the Cold. Brookings Institution Press, 2003.

Gaddy, Clifford G. and Andrew C. Kuchins, “Putin’s Plan: The Future of ‘Russia Inc,’” The Washington Quarterly, Volume 31, Number 2.

Desai, Raj M. and Itzhak Goldberg, eds. Can Russia Compete? Brookings Institution Press, 2007.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 21 Engaging an 7 Emerging India

By Eswar Prasad

ndia’s sustained growth surge since the beginning of The Global Context

Ithis decade has put the country at the center of the India boasts a large pool of educated labor, a young workforce, world economic stage, along with China, as one of major a booming service sector, and a growing manufacturing sector. Yet the country’s economic dynamism masks the fact success stories of recent years. With a burgeoning middle that it has a weak manufacturing base and that a substantial class and a large pool of educated workers, India seems proportion of its workforce is still engaged in low-productivity activities in the agricultural sector. The recent growth in the poised to remain on a trajectory of rapid growth for many manufacturing sector is promising, but this sector remains years to come. But this is far from certain. There are many hampered by restrictive labor market regulations that, for instance, make it difficult for medium-sized and large challenges on the domestic front—including weaknesses industrial firms to layoff workers even in economic downturns. in the physical infrastructure and educational system, This has resulted in a prevalence of smaller enterprises in the manufacturing sector that are not able to reap the benefits of poor public governance, high fiscal deficits, rising income economies of scale, making this sector a lot less dynamic and inequality, and domestic macroeconomic management a less effective source of job creation than it could be. And though the boom in services has boosted GDP growth, it has issues that have arisen through India’s integration into failed to create large numbers of jobs relative to the rate of the world economy. America must deepen engagement population growth. Therefore, India’s economic policy will need to focus both on maintaining the service boom and on with India to advance our common interests on energy finding ways to bring more people into higher-productivity and climate, services and trade and global governance. sectors like manufacturing.

22 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT The Challenge >> Domestic capital markets: India has undertaken a significant liberalization of its financial sector and has India and the United States are economic and political partners also opened up to capital flows from abroad. Its stock that share a desire for open, transparent and dynamic global markets, in particular, have become sophisticated and markets. India’s rising economic clout has been accompanied relatively deep, partly due to the influx of foreign funds. by its increasingly assertive role in international institutions However, its overall level of financial depth—a measure of and discussions of cross-border issues (both bilateral and the prominence of its financial system relative to the size multilateral), including trade and climate change. India’s of its economy—remains low by international standards. relationship with the U.S. has also matured, and there are Its financial system still has a number of weaknesses that now significant two-way flows of trade, finance and human are preventing it from creating a significant number of capital. If this relationship is well managed, it could foster a jobs and that could hinder overall growth. For instance, productive, mutually beneficial relationship that could help the government bond market remains relatively torpid both countries make progress toward their many common and the corporate bond market is very small. The banking objectives. Indeed, India’s rising prominence as a spokesperson system has a very low ratio of nonperforming loans, but for the entire group of emerging markets on many issues, this is at the cost of a high level of passiveness in lending, including the Doha Round of trade multilateral negotiations, which has resulted in India having one of the lowest ratios means that this relationship between the U.S. and India has of bank lending to GDP among emerging markets. These assumed even greater importance. outcomes are partly the result of restrictive government The new U.S. administration will need to consider several policies and also the consequence of the government using key issues: banks, especially state-owned ones, as a source of deficit financing (by getting them to buy government bonds) and >> Energy and climate change: In the past 15 years, India’s as a redistributive mechanism. carbon dioxide emissions per capita and as a share of world emissions have increased by about half. The country’s new >> Outsourcing: Growth in the service industry has been push into manufacturing will surely speed up this trend. the bright spot in the Indian economy, with the service But India is worried more about procuring sufficient oil sector as a whole now accounting for more than half of to fuel its economic boom than using energy efficiently GDP. Even though the high-end services sector (including and reducing emissions. Its climate change policy so far has business processing) accounts for just about 1 percent of been based on the quest for technological solutions, and it India’s GDP, this sector has received a lot of attention and has not been willing to sign on to emissions reductions or is seen in the U.S. as threatening domestic jobs. carbon trading—or pricing—schemes. This technology- based approach leaves it out of global climate agreements, America’s Opportunity reflecting a view it shares with China that developed countries should take the lead in implementing any climate change Given the commonality of interests between the two countries, agreement. The ratification of the Kyoto Protocol foundered it will be important for the next U.S. president to build and in the United States on the lack of inclusion of developing maintain a constructive partnership with India. Actions in countries. Together, the U.S. and India face steep challenges several areas could particularly help build momentum for a on climate change and energy policies and should work deeper, more enduring relationship: together to develop international policies and processes. >> Energy and climate change: The United States should >> Trade and the Doha Round: In the Doha Round of World encourage India to adopt sustainable growth strategies Trade Organization negotiations, India has played a leading and engage with the international community on climate role among the Group of 77, the largest intergovernmental change. Given India’s existing stock of inefficient state-owned organization of developing states in the United Nations, manufacturing firms and the potential growth of a more in pushing for reductions in agricultural subsidies in dynamic manufacturing sector, the country has an opportunity developed countries. However, fears over losing domestic to opt for more sustainable and efficient technology. manufacturing share to exports from China have led to a breakdown in negotiations. In response, India has begun >> Trade and the Doha Round: The United States should to pursue free trade agreements with the European Union continue to actively engage India in the Doha Round and the United States. These bilateral agreements could be negotiations. For the U.S. to enter a free trade agreement corrosive to the cohesion of the world trading system. with India would be an unfortunate turn of events for the

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 23 world trading system. Although positions have hardened on Want to Read More? both sides, there is a lot at stake, and continued dialogue will Berry, Suman, Barry Bosworth, and Arvind Panagariya, eds. be essential to not leave the negotiations completely stalled. India Policy Forum 2004. Brookings Institution Press and National Council of Applied Economic Research, 2005. >> Domestic capital markets: The Government of India has in the last couple of years appointed committees to Berry, Suman, Barry Bosworth, and Arvind Panagariya, eds. look into specific aspects of financial system reform and India Policy Forum 2005–06. Sage Publications, 2006. to lay out a broader blueprint for reforms in this sector. The United States should encourage the Reserve Bank of Berry, Suman, Barry Bosworth, and Arvind Panagariya, eds. India to take the recommendations of these committees India Policy Forum 2006–07. Sage Publications, 2007. seriously. As the recent financial crisis in the United States has made clear, no country has the luxury of not needing to Berry, Suman, Barry Bosworth, and Arvind Panagariya, eds. constantly update financial regulation in a way that keeps India Policy Forum 2007–08. Sage Publications, 2008. financial innovation under control without stifling it. Bosworth, Barry, and Susan Collins. “Accounting for >> Financial flows: The United States should work with Growth: Comparing China and India,” Journal of Economic India to increase flows of foreign direct investment to Perspectives, vol. 22, no. 1 (Winter 2008). expand the Indian manufacturing sector, and also work to reduce restrictions on foreign investors’ participation Panagariya, Arvind. India: The Emerging Giant. Oxford in India’s government and corporate bond markets. Such University Press, 2008. steps, in addition to increasing financial depth, could also make it easier for India to obtain financing for its massive Prasad, Eswar, and Raghuram Rajan. “Next Generation infrastructure needs. Financial Reforms for India,” Finance & Development, vol. 46, no. 3 (September 2008). >> Outsourcing: The new U.S. administration should proactively ensure the benefits of free trade are broadly Talbott, Strobe. “Why All Augurs Well for India- spread. Of course, it is important to strengthen the U.S. U.S. Relations,” July 2008, www.brookings.edu/ social safety net and social insurance for those displaced by opinions/2008/0703_india_talbott.aspx. competition from abroad.

>> Global governance: The U.S. should support permanent seats at the table for India at the United Nations Security Council, the Group of Eight and other multilateral forums.

24 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 8Revitalizing Ties to Latin America

By Mauricio Cárdenas and Leonardo Martinez-Diaz

elations between the United States and the 33 crises, and relatively feeble rates of growth and job creation have frustrated the expectations of the middle classes and the countries that make up the Latin American and R poor. Poverty, violence and inequality remain major—and in Caribbean region have fallen into a state of neglect some countries growing—challenges. in recent years. Washington’s policy focus has been Meanwhile, the region’s residents have grown increasingly consumed by terrorism and the wars in Afghanistan and alienated from the United States. In a 2007 Zogby poll of Latin American elites, only 14 percent of decisionmakers Iraq. In the process, Latin America and the Caribbean from the region described Washington’s handling of relations countries have dropped off the U.S. political radar with Latin America as “good” (13 percent) or “excellent” (1 percent). The remaining 86 percent thought U.S. policy screen. was “fair” or “poor.” But 27 percent of Latin American elites described China as the country they believe is most important to their region’s future—a close second after the United States The Global Context (30 percent). While the United States has been focused elsewhere, important trends have swept the Latin American and Caribbean region. Neglect of Latin America and the Caribbean and alienation The region’s countries have begun to diversify their economic from its leadership are proving costly to the United States and political relations. Brazil, in particular, emboldened by because no other region has a greater impact on the daily strong economic growth, has been pursuing a more active lives of Americans. Through their impact on flows of natural regional and global role. Democratic institutions have been resources, goods and investment, shifts in the region can affect strengthened in most countries in the region. Fiscal and the health of U.S. firms and the U.S. economy. In addition, monetary discipline have become a cornerstone of economic shifts in migration patterns can have an impact on U.S. labor policy. The region has also suffered from its share of financial markets, politics and society. The United States has a large

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 25 stake in the future of Latin America and the Caribbean, but America’s Opportunity unless it reengages with the region, its ability to influence The next U.S. president needs to pursue several opportunities transformative trends will continue to decline. in relating to the Latin American and Caribbean countries:

The Challenge >> Relaunch relations: The first step of the next U.S. administration should be a symbolic relaunching of For the United States, the challenge is how to design a relations with Latin America, starting with a reference to constructive agenda with the countries of Latin America and the region in the president’s inaugural speech and a series the Caribbean and to forge partnerships that can help it advance of visits by senior officials to the region. its short- and long-term strategic interests. With the exception of Europe, Latin America and the Caribbean is the region that >> Diversify the agenda for the region: U.S. policymakers most closely shares U.S. political and economic values and should diversify the high-level agenda for the region beyond institutions; rehabilitating the United States’ image in this counternarcotics, immigration, and trade to include energy region should be easier than elsewhere in the world. Key U.S. cooperation and integration, water management, financial interests in the region include not only pursuing the traditional regulation, environmental protection and competitiveness. counternarcotics and investment- and trade-promotion agendas Energy, in particular, is an area of high potential for but also promoting energy security, managing migration flows, hemispheric cooperation—to liberalize trade in ethanol, strengthening democracy and the rule of law, combating promote the integration of power grids, build stronger criminal networks and supporting efforts to build more cohesive safeguards for the peaceful development of nuclear energy and equitable societies in the region. and sponsor research to develop cellulosic ethanol and other renewable energy sources. There are a number of obstacles on the road to constructive reengagement. First is the powerful pull of more urgent >> Address U.S. fears and concerns: On the hard issues of challenges in the Middle East and Asia, which divert high- trade and immigration, the next administration will make level attention and resources from Latin American and no progress unless it first directly addresses the American Caribbean issues. Second is a strong temptation to treat public’s fears and concerns. Without expanding and the region as a single entity, though it has a number of very strengthening Trade Adjustment Assistance and investing different political and economic structures. What is needed in U.S. competitiveness, there will be no domestic is a creative mix of bilateral, subregional, and hemispheric constituency for expanded trade with Latin American institutions and initiatives. and Caribbean (or other) countries. In addition, the U.S. government would be well advised to renew its efforts Third, some leaders in the region (especially Hugo Chávez, to pursue a hemispheric agreement rather than rely Evo Morales, and Fidel Castro) have exerted too strong an exclusively on bilateral trade deals, which cause trade adversarial hold on Washington’s attention, often pushing it diversion and create regulatory confusion. Finally, without into costly, counterproductive confrontations. Instead, U.S. a system that ensures the safe, legal and temporary policymakers should focus on understanding these leaders’ movement of the region’s workers into the sectors of the interests and the configuration of economic and political forces U.S. economy that need them most, progress on that keep them in power. A fourth obstacle is that U.S. policy immigration will remain elusive. tends to alternate between neglect and obsessive attention to a few issues that affect Americans directly, such as drug >> Strengthen regional institutions: The weakened trafficking and migration. What is needed is more consistent, Organization of American States could serve as a useful forum sustained attention on a wider scope of issues, including those for promoting regional security cooperation and democratic that Latin American and Caribbean governments see as shared institutions. But first, the OAS needs to be strengthened challenges, and those issues in which hemispheric cooperation financially and institutionally. Another institution ripe for is essential for progress. improvement is the North American Development Bank, set up to finance environmental protection projects in the U.S.-Mexico border region. An informal steering committee, modeled on the Group of Seven and composed of heads of state from the region’s most important countries, could help guide the work of regional institutions and strengthen cooperation.

26 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT >> Contribute to the region’s social agenda: U.S. policymakers Want to Read More? need to identify opportunities for the United States to Brainard, Lael, and Leonardo Martinez-Diaz, eds. Brazil as contribute to the social agenda in Latin American and an Economic Superpower? Understanding Brazil’s Changing Caribbean countries. This means rethinking U.S. aid policy Role in the Global Economy. Brookings Institution Press, toward the region, improving aid coordination with other forthcoming. donors and directing aid to those sectors where the impact will be greatest per dollar spent. U.S. aid agencies should De Ferranti, David, and Anthony J. Ody. “Key Economic also be more transparent about the purposes of their aid to and Social Challenges for Latin America: Perspectives from the region’s countries (poverty reduction, counternarcotics, Recent Studies,” Brookings Institution, 2006. security) and should evaluate that aid’s effectiveness only on the basis of its intended purpose. Desai, Raj M., and Itzhak Goldberg. “Perestroika Cubana,” National Interest, August 29, 2007.

Martinez-Diaz, Leonardo. “Latin America: Themes for the Next Quarter-Century,” World Policy Journal, Fall 2008.

Martinez-Diaz, Leonardo, Michael O’Hanlon, and Diana Villiers Negroponte. “A Dialogue: Engaging the Latin American World,” Opportunity 08, Brookings Institution, 2007.

Partnership for the Americas Commission. Commission Report. Brookings Institution, forthcoming, November 2008.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 27 Supporting 9 Africa’s Growth Turnaround

By John Page

fter three decades of low and volatile growth, significantly more growth booms in the past 10 years than their non-resource-rich neighbors. But good policy has also played a AAfrica’s economic performance has markedly part. Macroeconomic management has been strengthened. Fiscal improved in recent years. Since 1994, its average deficits and inflation have declined dramatically since 1995. Exchange rates have become more flexible and competitive. economic growth has been close to 5 percent a year. Political and economic institutions have also improved, and Today Africa’s per capita income is rising in tandem with the number of conflicts has declined. These changes have contributed significantly to a sharp fall in growth collapses for that of the rest of the world. the resource rich and resource poor alike.

The Global Context The Challenge What explains this dramatic turnaround? Africa’s long-run The issue now is to sustain growth. Though there is no single growth masks a striking pattern of offsetting booms and prescription for success, Africa’s leaders are likely to face five busts. Between 1975 and 2005, the average African economy major challenges to varying degrees: grew more than 3.5 percent a year a quarter of the time but contracted by about 2.5 percent another quarter of the time. >> Using natural resources well. If the history of the resource- This pattern changed in 1995, when the booms began to be rich countries in Africa is any guide, rather than bringing more frequent and the busts became much rarer, thanks to prosperity, oil and other minerals may well leave a legacy two factors: good luck—resource-driven growth booms—and of weak public institutions, boom-to-bust macroeconomic fewer mistakes—avoiding busts. management, economic stagnation and inefficient public expenditures. Strengthening the institutional foundations High export prices for virtually all of Africa’s commodities have of natural resource revenue management—in particular meant that the continent’s resource-rich economies have had checks and balances on revenue contracts and public

28 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT expenditures—is critical for turning natural resource wealth administration should support developing international into sustained growth. standards and codes of conduct to promote transparency and accountability covering issues such as mineral rights, >> Creating an export push. For economies without substantial tax regimes, fiscal rules and public investment. International natural resources, the rapid growth of nontraditional norms can both support reformers in the resource-rich exports offers an important way to boost growth. African economies and encourage responsible behavior on the part exports, however, particularly nonoil exports, are growing of extractive industries. slowly and are highly concentrated in a few products. To generate new dynamism in nontraditional exports, Africa >> Confronting rising protectionism: International trade will need an “export push,” supported by appropriate trade is fundamental to sustaining growth in Africa. An export and exchange rate policies, by effective export promotion push needs market access. Yet according to a recent Wall institutions and by efficient, trade-related infrastructure. Street Journal / NBC News poll, 60 percent of voters nationwide agreed that “foreign trade has been bad for the >> Strengthening the private sector. Private investment in U.S. economy.” In the face of such adverse public opinion, Africa is low, and except for foreign direct investment in it will be difficult but imperative for the new administration resource-rich countries, it has not increased since 1995. to strengthen the Africa Growth Opportunities Act. Despite recent reforms, Africa remains a high-cost, high- Imparting new energy to the Doha Round of multilateral risk place to do business. It is essential to improve Africa’s trade talks is also critical; many of Africa’s most promising investment climate by reducing excessive regulation and trade partners are newly industrializing members of the corruption, building up its essential business services and World Trade Organization. closing its infrastructure gap with the rest of the world. >> Supporting the private sector: The United States can help >> Building new skills. Africa has scored a major success in empower the private sector to do business in Africa. The primary education; the gross primary school enrollment U.S. Overseas Private Investment Corporation can help U.S. rate stood at 92 percent in 2004. But there have been businesses invest in Africa by mitigating risk. The Millennium no comparable increases in secondary and tertiary school Challenge Corporation can foster stronger linkages with the enrollments. The lack of expanded access to and improved African private sector. America can also take the lead in quality in postprimary education has serious implications forging a consensus in the international donor community for long-term growth. Africa needs new skills to compete to support building up skills for competitiveness. and new approaches to postprimary education. >> Promoting peace and security: Poverty is both a cause >> Enhancing resilience. Africa will perhaps suffer the most of insecurity and a consequence of it. Fragile states can from climate change because of its size, large impoverished explode into violence or implode into collapse, imperiling populations and stage of development. Without integrating their citizens, regional neighbors and the wider world as climate risks into development planning, Africa risks livelihoods are crushed, investors flee and ungoverned undermining its growth. For example, in some African territories become a spawning ground for global threats countries agricultural yields could drop as much as 50 like terrorism, trafficking, environmental devastation and percent by 2020. For a region heavily reliant on agriculture disease. The new administration should intensify efforts for overall growth, these projections make a compelling case to support effective collective solutions—through the for the need to climate-proof vulnerable cities, populations African Union and the United Nations—to conflict across and sectors. the region. There is also a role for unilateral efforts. The U.S. Africa Command created in 2007 should continue to strengthen the capacity of its African counterparts but at America’s Opportunity the same time avoid expanding its mandate into the realm Africa’s long-run success ultimately rests on the actions of of humanitarian assistance. its people and their leaders, but the United States has an important role to play in supporting their efforts. The new >> Redefining the aid agenda: The new administration will U.S. administration can take a number of steps to support have an important opportunity to change the priorities Africa’s growth turnaround: for U.S. assistance to Africa. Aid volumes to Africa have increased, but the bulk of the United States’ $4.6 billion in >> Supporting global standards for natural resource aid to Africa in 2005 has gone to technical assistance and management: Given how central the effective use emergency relief. The highest priority should instead be of natural resources is to Africa’s prosperity, the next to meet the Group of Eight’s Gleneagles commitment to

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 29 double aid to Africa by providing more assistance directly Want to Read More? to projects and programs that support long-term growth Arbache, Jorge Saba, and John Page. More Growth or Fewer and human development. Funding priorities should target Collapses? A New Look at Long Run Growth in Sub-Saharan projects that are carbon neutral and build resilience to the Africa. Policy Research Working Paper 4384, World Bank, adverse effects of climate change. The new administration 2007. should also challenge the rest of its G8 partners to make similar outcome-based aid commitments. Brainard, Lael, and Derek Chollet, eds. Global Development 2.0: Can Philanthropists, the Public, and the Poor Make >> Building bridges to new donors: China is building a hefty Poverty History? Brookings Institution Press, 2008. bilateral development assistance program in Africa: providing $5 billion in preferential loans and export credits in the next Brainard, Lael, and Derek Chollet, eds. Too Poor for Peace? three years; doubling aid from 2006 levels by 2009; and Global Poverty, Conflict and Security in the 21st Century. establishing a $5 billion China-Africa Development Fund to Brookings Institution Press, 2007. encourage Chinese direct investment. And China is not the only new donor. India, a number of other Asian countries, Easterly, William. 2007. How the Millennium Development and several large foundations are also involved in Africa. To Goals Are Unfair to Africa. Brookings Global Economy date, these new donors have been reluctant to coordinate and Development Working Paper 12, www.brookings.edu/ their efforts with Africa’s traditional development partners. papers/2007/11_poverty_easterly.aspx. The U.S. can help improve the effectiveness of all aid to Africa by leading efforts to build greater communication, Go, Delfin, and John Page, eds.Africa at a Turning Point? collaboration and coordination among all development Growth, Aid, and External Shocks. Africa Development partners and African governments. Essay, World Bank, 2008.

Rice, Susan E. and Stewart Partrick, “Index of State Weakness in the Developing World,” The Brookings Institution, February 2008. http://www.brookings.edu/ reports/2008/~/media/Files/rc/reports/2008/02_weak_states_ index/02_weak_states_index.pdf

Rice, Susan. “The Threat of Global Poverty. The National Interest,” 2006, www.brookings.edu/articles/2006/spring_ globaleconomics_rice.aspx.

30 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 10 Pursuing a Positive Agenda for the Middle East

Navtej Dhillon, Djavad Salehi-Isfahani and Tarik Yousef

he Middle East is currently experiencing a double Yet this Middle Eastern demographic asset is vastly underrecognized and underutilized. Though the transition to dividend: an unprecedented oil boom, with T adulthood is an inherently difficult period, Middle Eastern global prices hovering at or near $100 a barrel, and a youth face greater challenges than their peers in Latin America or East Asia. In the Middle East, youth unemployment rates demographic gift in the form of a large youth population. are nearly twice the world average (25 vs. 14 percent), and Though high oil prices and a large unemployed youth the time required to wait for a first job is measured in years rather than months. Education, which in other regions is a population are frequently viewed as contributing to way for youth to ease their transition to employment, fails to economic volatility and social instability, with the right do the same in the Middle East. Furthermore, a large majority of youth must live with their parents well into their 20s and policies these twin dividends could yield greater global delay marriage, despite greater social taboos for relationships prosperity and security. outside marriage.

The Middle East pays a high cost for the economic exclusion of youth; our recent research shows that estimates are as high The Global Context as $53 billion in (17 percent of GDP) and $1.5 billion Among all the world’s regions, the Middle East contains the in Jordan (7 percent). While the youth bulge is itself a source highest proportion of youth, who make up almost a third of of economic growth, it can also provide the social and political its total population. With two working-age people (15 to 64 impetus for lasting institutional change. This is because many years of age) living in the region for every one non-working-age of the problems youth face—skill mismatches, unemployment, person (under 14 or over 65), it faces a historic opportunity lack of access to credit—are the result of the institutional to harness its own economic tiger by increasing incomes per infrastructure that governs education, employment, housing capita, bolstering savings and improving social welfare. and other key markets. These state-dominated institutions,

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 31 when first established, were designed with strong social These are all areas where the United States is a leader. As the justice objectives; but today, in a much more competitive country with the world’s best record in harnessing the energy global economy, they hinder . Thus of youth, the U.S. can offer much to the Middle East. The the Middle East’s increased stability and prosperity hinge on challenge is how the U.S. can build on its strengths and be making economic reforms before the region’s demographic seen as genuinely interested in reform, not just in curbing window of opportunity closes and its societies begin to age. radicalism. The next American president must recast the U.S.– Middle East relationship on broader terms—seeking to move beyond security to comprehensive engagement. Promoting The Challenge reforms in the name of youth is the only workable template The next U.S. president faces obvious tough questions about for exercising soft power that can encourage the best impulses how to reengage in the Middle East without antagonizing of the Middle East. the region’s policymakers and people. Given suspicions about current U.S. policies and objectives in the region, how can the next administration help encourage critical economic and America’s Opportunity political reforms there while fostering more favorable views Given this challenge, the next U.S. president will have the of the U.S.? The key lies in shifting the political and policy opportunity to: discourse from the fight against Islamic radicalism to how to build a future for the majority—from using hard power to >> Change U.S. discourse to focus on youth-focused boosting smart power. economic development in the Middle East: Addressing the Middle East through the prism of Islamic extremism, A recent Gallup poll of Muslim countries revealed that when however well intended, ends up alienating the majority of asked what the West can do for Muslims, the number one moderate citizens. It undercuts the government reformers response was to “reduce unemployment and improve the who should be supported and contracts the space in which economic infrastructure.” When asked to describe their dream U.S. and Middle Eastern civil society, private sector and for the future, the majority of Muslims cited getting a better public institutions can build partnerships based on trust job. The same survey also revealed that respondents believe that and mutual respect. The new discourse on economic and the United States can improve relations with the Arab world by political reform should be aligned with the aspirations of demonstrating more respect and not underestimating the status the majority of the people in the Middle East: the young of Arab countries. The message is loud and clear: U.S. rhetoric who are striving for global integration. should affirm respect and inspire local ownership, and the best U.S. efforts should be focused on economic development. >> Make greater investments in supporting Middle Eastern youth: Most development programs targeting youth focus Yet many youth in the Middle East have witnessed the reverse. on improving education, training those who are unemployed Most of these youth have had their perceptions of America or providing them with credit without understanding the shaped by the events of the past eight years: the 9/11 terrorist linkages between these diverse sectors or addressing the root attacks, the U.S. war on terrorism and Islamic extremism, causes of youth outcomes. The result is a missed opportunity the stalemate in the Arab-Israeli conflict, the wars in Iraq to use youth programs to create incentives and institutional and Lebanon. Young people find themselves portrayed in the changes, and to generate success stories for reform-minded West as in the grip of fundamentalist ideology and a source leaders seeking to shape policy. The United States can play of security threats. Where public U.S. diplomacy has made a critical role by amending the Foreign Assistance Act and overtures, it has often been out of sync with local realities. exporting soft technology, as noted next.

Paradoxically, the chasm in U.S.–Middle East relations has >> Amend the Foreign Assistance Act to provide resources emerged amid greater convergence in ideas and aspirations. for youth in developed countries. Currently, the Foreign Triggered by a large youth cohort, the Middle East is undergoing Assistance Act only funds a few youth activities in countries change where it is aligning with the fundamental drivers of experiencing conflict or crisis. Thus, the legislation and globalization. The region has embraced the ideas of a market programs are rewarding the bad behavior of these countries, economy; it values education and civic participation is on a form of moral hazard in foreign policy. The act’s language the rise. Middle Eastern youth subscribe to the fundamental should be changed to overcome this policy flaw. Youth progrowth norms of behavior such as hard work and high development should be given priority, particularly in investment in children, including girls. countries experiencing youth bulges and high rates of youth unemployment.

32 BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT >> Export soft technology for institutional reform of Dhillon, Navtej, and T. Yousef. “Inclusion: Meeting the 100 education. Youth in the United States have a relatively Million Youth Challenge.” Middle East Youth Initiative smooth transition to adulthood compared with those in Report, Wolfensohn Center for Development at Brookings most advanced countries. Transitions to adulthood in the and the Dubai School of Government, 2007. United States are facilitated because of the close integration between the education system and the labor market. U.S. Kabbani, N. and N. Kamel. “Youth Exclusion in Syria: institutions may not fit the Middle East perfectly, but as Social, Economic, and Institutional Dimensions.” Working with all exports, soft technology exports can be adapted Paper, Wolfensohn Center for Development at Brookings to fit local conditions. The U.S. educational system has and the Dubai School of Government, 2007. already provided the region with excellent institutions of higher education—the American University in Beirut and Salehi-Isfahani, Djavad, and Navtej Dhillon. “Youth the American University in Cairo—which have produced Transitions to Adulthood in the Middle East: Toward a many of the region’s leaders. The U.S. can extend assistance Policy Framework.” Working Paper, Wolfensohn Center on a broader scale, encompassing curricular reform for high for Development at Brookings and the Dubai School of schools, the transition from high school to college (through Government, 2008. reforms of admission practices), and the transition from school to work. Salehi-Isfahani, Djavad, and D. Egel. “Youth Exclusion in Iran.” Working Paper, Wolfensohn Center for Development at Brookings and the Dubai School of Government, 2007. Want to Read More? Assaad, R., et al. “Youth Exclusion in Yemen.” Working Silver, Hillary. “An Exclusion Framework for Youth in Paper, Middle East Youth Initiative, Wolfensohn Center the Middle East.” Working Paper, Wolfensohn Center for Development at Brookings and the Dubai School of for Development at Brookings and the Dubai School of Government, forthcoming, 2008. Government, 2007.

Assaad, R., and G. Barsoum. “Youth Exclusion in Egypt.” Singerman, Diane. “The Economic Imperatives of Marriage.” Working Paper, Wolfensohn Center for Development at Working Paper, Wolfensohn Center for Development at Brookings and the Dubai School of Government, 2007. Brookings and the Dubai School of Government, 2007.

Chaaban, Jad. “The Cost of Youth Exclusion in the Middle East.” Working Paper, Wolfensohn Center for Development at Brookings and the Dubai School of Government, 2008.

BROOKINGS GLOBAL ECONOMY AND DEVELOPMENT 33 Brookings Global Economy and Development was launched in 2006 as the fifth major research program. Brookings Global examines the opportunities and challenges presented by globalization, which has become a central concern for policymakers, business executives and civil society, and offers innovative recommendations and solutions to materially shape the policy debate.

Global Economy and Development scholars address the issues surrounding globalization within three key areas: >> The drivers shaping the global economy >> The road out of poverty >> The rise of new economic powers

The program is directed by Lael Brainard, vice president and holder of the Bernard L. Schwartz Chair in International Economics.

The program also houses the Wolfensohn Center for Development, a major effort to improve the effectiveness of national and international development efforts.

1775 Massachusetts Ave, NW | Washington, DC 20036 (Phone) 202.797.6000 | www.brookings.edu/global